Risk Tolerance Revisited

Learning what makes your client tick will help prevent losses in his portfolio.

By Donald Ray Haas, CLU,
ChFC, CFP, MSFS

In my January column,
we began the New Year with a discussion of risk tolerance. Even though the
column argued that risk tolerance questionnaire scores do not tell advisors
which products to recommend, the financial services industry continues to
use this information improperly in the advisor-client relationship. Only your
clients' needs, time frames, and resources determine the proper products and
services to recommend. Instead, the questionnaire scores reveal how much clients
understand about financial matters and what knowledge they may lack. Only
then, armed with this knowledge, should you prepare your clients to make financial
decisions that will help them accomplish their goals.

The key
to moving clients from their initial comfort level to a more risk-appropriate
comfort level is education.

February's column focused
on a planning tool I have used successfully for more than 25 years. In March,
we discussed what clients' risk tolerance level means—or their perception
of their attitudes toward financial matters. For the advisor, the clients'
scores really indicate the degree of their understanding of how an investment
or financial concept operates. From this information, an advisor can determine
how much teaching is necessary to increase his clients' comfort level. Sometimes,
the scores tell us approximately how much time it will take to reach a comfort
level that is compatible with the risk needed to accomplish the clients' financial
goals.

Educating your clients
The key to moving your clients from their initial comfort level to a more
risk-appropriate comfort level is education. But your work is not yet done.
Once a client successfully moves from a too high or too low risk tolerance
level to the center, continue to monitor him closely. Often, a client will
gravitate back to the original level. Also, the client may feel uncomfortable
until a "healthy" time span has elapsed. Prevent your clients from
this regression through education and handholding. Reassure them—especially
during extremely volatile market conditions.

Evaluating and understanding
a client's financial attitude is necessary to avoid the total destruction
of any portfolio. When there's a crisis, a client with a low score—meaning
one with a lack of understanding/knowledge—may sell prematurely. On the
other hand, a client who is a more aggressive investor will sell slower-performing
vehicles, which could totally unbalance even the best portfolio.

For example, in March
2000, one of my clients, who is an aggressive investor, wanted to sell everything
and put his money in the technology sector. This would have been foolish,
and I tactfully counseled him as to why he should not make this move. As you
know, the NASDAQ went from 5,000 to under 2,000—a 60 percent drop. Fortunately,
my client took the advice.

In trying to learn what
makes your client tick, start with a risk tolerance questionnaire. Review
the client's current investment portfolio and its historical changes. Look
at income tax returns, which provide additional insights into how the client
has acted in the past. And, of course, interview the client in person. Be
sure to subordinate your personal interest to that of the client's. Develop
thorough fact-finding techniques, improve your listening skills, and what
is most important, really invest time in exploring each client's situation.

Now, you're probably thinking:
"Who has the time for all this?" While it's true that all of us
need to make a living and our lives are extremely busy, you need to make the
time for each client if you are going to hold yourself out as a professional
financial advisor.

Think of it this way:
Your commitment is the same whether you take the time to educate your client
and develop his risk comfort level, or you try to find a new client. Remember,
a long-term client has time to develop a high level of trust, which will inevitably
result in the need for more financial products and services. This, in turn,
will create more compensation for you.

But, maybe what is even
more important, by spending time with your client, you will gain the utmost
benefit by having done your job well.

Donald Ray Haas, CLU,
ChFC, CFP, MSFS, of Southfield, Mich., can be reached at 248-213-0101 or at
donaldhaas@aol.com.